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How to Use 401(K) Funds to Start a Business

Since 2008, the credit crunch has made it more difficult than ever for entrepreneurs to access credit. While lending is loosening, entrepreneurs are still having a difficult time getting funding to start or recapitalize a business. It’s safe to say we are never going to return to the lending environment where you could obtain the “Ninja” loan –No Income- No Job – No Assets.

As a result many entrepreneurs have sought to find alternative ways to fund their businesses. One of the more popular strategies has been to utilize their retirement funds to start or recapitalize their business. This strategy more commonly known as Rollover for Business Startup (ROBS) has been around for several years, and has seen a dramatic increase with the tight credit markets. In fact, in recent years as much as 10% of franchises sold utilize this program as part of the funding strategy. Let’s look at some reasons for the dramatic increase in the popularity in this funding strategy.

In 1974- ERISA legislation (Employee Retirement Income Security Act) allowed the creation of qualified retirement plans such as IRAs and 401(K)s. These plans allow American’s to save for their retirement with pretax dollars. Because of their tax advantage nature, most American’s have the majority of their savings in these types of plans. When an individual decides to become an entrepreneur and wants to access their retirement saving to fund their new venture, they are faced with losing a significant portion of their savings to penalties and taxes. Let’s look at an example:

In the given example, if you are under 59 ½ years old, your hypothetical $200,000 savings would be subject to a 10% early withdrawal penalty of $20,000, leaving $180,000. In addition, there would be state and federal income tax due, siphoning off as much as 30% or $60,000. As a result, after paying the required taxes and penalties,you are left with only $120,000 of your original $200,000 savings. Losing 40% of your savings is not a good way to start your business. Rollover Business Funding allows you to use your retirement savings, tax deferred and penalty free, therefore the full $200,000 of your savings is available to purchase or recapitalize your business.

What are the benefits?

You can use this program for the capital injection needed for an SBA loan

You use pre-tax dollars to fund your business

You gain an improved cash flow position from the start

You can use the funds to receive a salary during startup

You accelerate business profitability by eliminating or reducing interest and debt

You secure funding fast—typically in two to three weeks or less

How does it work?

If you have an IRA, 401(k) or other qualified retirement plan, you may find this strategy is the right choice for you and your business.

About the Author(s)

Dallas is a frequent presenter at small business events, educating entrepreneurs on small business funding strategies. Prior to his role at Benetrends, he was a Managing Director at Knott Capital Management, an equity investment advisory firm.
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